Global Economics

Olympic Diplomacy: Don't Fear China

The mainland has everything to gain from a stable relationship with the U.S. It's not going to act rashly, and neither should America

Advocates of a get-tough approach with China are dismayed that President Bush has not joined European leaders in declining to attend the opening ceremony of the Beijing Olympics. They regard this as proof positive that open trade between the U.S. and China has allowed the mainland to acquire too much clout over our economy, causing us to lose our diplomatic nerve.

But the notion that trade has made America more vulnerable to political manipulation by the Chinese is both bogus and backwards. If America fails to persuade China to mend its behavior toward Tibet, Darfur, and domestic dissidents, that will reflect a failure of our diplomatic—not trade—policy.

Greater trade with China has always been controversial with certain liberals and conservatives. But their protectionism is finding bigger resonance this election season, as both Senators Hillary Clinton and Barack Obama adopt economically populist messages to court blue-collar voters. Senator Clinton, whose husband, more than anyone else, was responsible for normalizing trade ties with China, is now sounding the alarm about "our slow erosion of economic sovereignty" and hinting at trade restrictions against that country. Not to be outdone, Senator Obama has criticized U.S. borrowing from China. Why? Because it's "very hard to tell your banker he's wrong."

McCain Supports Free Trade

Nor are liberals like Senators Clinton and Obama alone in questioning America's trade relations with China. To his credit, Senator John McCain, the Republican Presidential nominee, has not allowed his disdain for China's human rights abuses and oppression to derail his support of more open trade ties with the country. However, Representative Duncan Hunter, one of his former rivals for the Republican nomination, made the "economic threat" that China poses to America a central plank of his platform.

But are fears that China can bring America's economy to its knees justified? Not at all: China has neither the economic clout nor the economic desire to hurt the U.S., unless it wishes to commit economic suicide itself.

It is true that in the last decade or so China's once-insular economy has vastly expanded its overseas financial holdings. Its export-led growth has produced a $1.4 trillion trade surplus—handing it the world's largest foreign exchange reserves. About 70% of these are invested in America—$400 billion or so in U.S. treasury bonds and the rest in private stocks, corporate bonds and other investments.

China Owns Just a Fraction of U.S. Debt

That China is choosing to invest its reserves in this country ought to be viewed as a huge compliment, a vote of confidence in the U.S. economy. Instead, China-bashers believe that allowing China to own U.S. government debt is tantamount to putting a nuclear bomb in its hands: All that Beijing needs to do is dump U.S. bonds. This will crash the U.S. dollar, especially now, when it is already in a weakened state, making it useless as the world's reserve currency, the main source of America's status as the world's economic superpower.

But should China attempt to detonate this bomb, its own economy would be buried under debris long before America even heard the explosion.

For starters, given Uncle Sam's overall $9 trillion debt, China's $400 billion constitutes barely a day's trading in U.S. treasuries. A Chinese dollar sale would produce some economic ripples in the U.S. economy, observes Dan Griswold, director of trade policy at the Cato Institute, but no lasting impact. "Contrary to popular belief, the Chinese simply are not very big players," Griswold says.

Giving Away Free Money

But even if it could, China wouldn't make any precipitous move to weaken the dollar because doing so would instantly lower the value of its own foreign reserves. As the late Nobel prize-winning economist Milton Friedman explained, foreign governments that make distress sales of their dollar holdings to destabilize the U.S. economy usually have to sell at below-market value. There would be plenty of buyers for these assets, so their overall value would not suffer. But the sellers would lose big time because they would effectively be giving away free money. (China has lately started diversifying its reserves into euros and other currencies as they strengthen against the dollar, but that's to maximize the returns on its investments, not out of political spite against the U.S.)

Furthermore, to the extent that Chinese authorities do slow the American economy, they would make the U.S. less capable of absorbing China's exports. This would have major political reverberations, given that America is China's biggest export market. Indeed, Chinese workers making, say, toys for Wal-Mart (WMT) will not simply sit by quietly while their jobs vanish.

The truth is that opening the U.S. to Chinese investments and exports has given China an enormous stake in America's economic health. In fact, last year, when statements by a Chinese academic triggered rumors that a China dollar dump was imminent, Chinese officials quickly issued a statement that "China doesn't want any undesirable phenomenon in the global financial order."

Desperate for International Respectability

What's ironic is that China worrywarts who have long complained that China deliberately undervalues the yuan to discourage U.S. exports are now concerned about the opposite: China shedding its dollar reserves, even though the net effect of this would be to raise the value of the yuan against the dollar, precisely as they want.

None of this is to suggest that the U.S. should sit back and do nothing to hasten China's political liberalization. Indeed, the Olympics offer America and other Western countries an important opportunity to coax better behavior from China. The very fact that China wanted so badly to host the Games and has gone to the trouble of orchestrating the elaborate intercontinental relay of the Olympic torch suggests how desperate it is for international respectability. The last thing China wants is a massive showdown with protesters during the festivities.

Indeed, the Olympics offers powerful testimony, not to the clout that economic engagement has given China over the U.S., but the reverse: the clout that the U.S. and the international community have acquired over the mainland. It is significant that Beijing recently held talks with a representative of the Dalai Lama. It is highly unlikely that this will produce any major political breakthroughs overnight. Beijing after all is performing a double-dance—simultaneously trying to mollify the international community while averting a nationalistic backlash at home that too many concessions would likely trigger.

An Argument for Soft Diplomacy

Given this backdrop, there is an argument for the kind of soft diplomacy that President Bush is pursuing, as opposed to the threats and boycotts that human rights advocates and European leaders are advocating. However, if as the Games approach this strategy fails to yield sufficient progress, President Bush would be entirely justified in taking a harder line and even canceling his Olympic sojourn. This would make a far bigger political statement than refusing to attend now. But if President Bush does decline to attend the Games, he should do so without fearing an economic backlash: China would have everything to lose by pulling the trigger, and the U.S. not so much.